In January, Financial News hosted a live webcast sponsored by CME Group to explore how firms are preparing for the latest regulation. The following is an edited version of that discussion.

European trading firms face a year of regulatory indigestion. Key G20 reforms on trade reporting and clearing are set to take effect through the European Market Infrastructure Regulation. Financial benchmarks will be under the microscope and a financial transaction tax is on the horizon.

Regulators have also reached a deal on new rules for Mifid II and the European Securities and Markets Authority will be consulting on the details that will underpin the new rules.

The panel

Darren Lazarus, Executive editor, special reports, Financial News

Alex Lenhart, European head of listed derivatives and OTC clearing, Credit Suisse

DL, Financial News: On February 12, trade reporting will come into effect in Europe. This means that firms will need to report all their over-the-counter and listed trades to repositories or information warehouses. Are your clients ready for trade reporting?

WK, CME Group: In theory, it should be easy to know whether firms are ready by looking at how many of them have Legal Entity Identifiers. Unfortunately, because LEIs are given out by 28 different countries in Europe, as well as the US, it is very difficult to get that number correct.

We think that certain elements of the market are ready, but by no means everyone. Think about this in terms of the number of trades per day that have to be reported: five million futures exchange-traded derivatives transactions, 10,000 to 20,000 of OTC swaps and 250,000 to 500,000 FX forwards. Unfortunately, there is no common mechanism to make those trades look identical. This will create issues in the market, especially with FX forwards, which have limited electronic trading, matching and messaging, and will have to be reported very differently to the exchange-traded derivatives market.

We think that in Europe, about 100,000 entities will have to report. In Germany, for instance, there are about 40,000 but we understand that only 18,000 or 19,000 LEIs have been issued. It is difficult to establish the number in the UK but we know the London Stock Exchange has issued about 3,300.
Over the last few months, we have seen a significant increase in people’s acceptance that they need to be ready, but over the next few weeks there is a lot of work to be done.

DL, Financial News: From a buyside perspective, is there a sense that firms are ready?

RM, Investment Management Association: We are not getting members coming to us saying that we have to try to stop reporting happening. I know it does not prove that everybody is ready, but we are getting a sense that, certainly, the bigger participants have been pretty focused on this and that has led to some fairly concentrated thinking about whether or not they want to delegate reporting – and if so, how and on what terms. There are clear signs that just as they are thinking about clearing agreements so they are focused on trade reporting too.

AL, Credit Suisse: From a client perspective, we continue to provide education on reporting requirements. Last month, for example, we had a few hundred clients on a call discussing the topic. We offer what we call Roboc (reporting on behalf of clients). Quite a few clients will delegate their reporting obligations to us and we will report on their behalf.

I think the Financial Conduct Authority will be lenient about Day 1 reporting requirements. If things don’t go 100% smoothly, firms will probably be allowed a bit more time to get it right. But I don’t believe you can pursue a strategy that involves burying your head in the sand. We hope to be ready and think the marketplace, in general, should be ready.

DL, Financial News: What are the options for delegated reporting? And where does the legal liability lie?

EL, Societe Generale: I would like to highlight that, unlike the Dodd-Frank regulations in the US, the European Market Infrastructure Regulation requires reporting to be two-sided. Until now, it has been one-sided, which effectively means that dealers have been reporting transactions, as opposed to both parties reporting their transaction, which brings into the scope of reporting a range of new actors, who previously had been blithely unconcerned.

I agree that the dealers will, broadly speaking, be ready, which means most transactions will be reported. Does that mean most parties will be reporting? I am not so sure, because the further you go down the chain of infrequently trading entities, the less likely they are to be ready.

Emir allows for delegated reporting. Broadly speaking, there are two commercial offers out there at the moment. One involves dealers offering to report their clients’ trades with themselves but not with other trading parties. The other is a more full-service commercial offering, where entities (not necessarily dealers only) offer to report the entirety of a user’s transactions.

That still raises the issue of who carries the liability. Emir requires the transactor – the end-party – to be legally responsible for the quality of what is reported, and that is not something you can readily transfer. It is not something that banks, dealers and other reporting entities are keen to take on because, in most cases, there is not a compelling commercial logic to offering reporting.

The International Swaps and Derivatives Association recently published a standardised reporting contract which clearly lays out the view that, ultimately, liability belongs to the client, while the dealer or other reporting party is liable for negligence.

DL, Financial News: Does that mean some clients are prioritised over others? Are bigger firms that trade regularly offered delegated trading but not the smaller ones that maybe only trade a few times a year?

EL, Societe Generale: It is not evident, because the bigger firms may actually have an incentive to develop their own reporting.

WK, CME Group: Some of the larger asset managers have taken on that role themselves. The smaller entities are one of the reasons we came up with delegated reporting. We can do it for the transactions we are in control of, but we will also take all other transactions.

RM, Investment Management Association: From the IMA’s perspective, we are seeing that some people are going down the do-it-yourself route. Part of the consideration is the fact that you do not just report the trade – there are continuing reporting requirements. In gathering that sort of information on valuations and collateral, it may actually make sense for some firms to cut out the middleman.
We probably all hope that, from the regulators’ point of view, this is going to be about proportionality, because the whole point about trade repositories is to pick up systemic concentrations of risk.

What happens when firms are not ready?

DL, Financial News: What will the regulators do when a firm isn’t ready for trade reporting? What is the worst that can happen? Will we see people move out of the market out of fear that they are not properly set up?

WK, CME Group: It is going to be interesting. In the US, we have the advantage of first-hand experience. When regulations on swaps clearing came in, we initially saw the volume of OTC transactions drop off, and then as people became comfortable with the concept, it picked up again.

EL, Societe Generale: Surely, the two-sided nature of the reporting makes a difference? In the US, there was certainly a blip in traded volumes, but that quickly re-established itself, primarily as dealer firms got their infrastructure into place. In Europe, you are talking about end-users who have to face up to potential liability and that is something that they will be concerned about. I agree it will re-establish itself over time, but I think the blip might last longer.

RM, Investment Management Association: In the world of OTC derivatives, the rate of growth has dropped dramatically, according to the most recent survey in 2013. I think the dollar OTC derivatives market went down in terms of daily average by a couple of per cent between 2010 and 2013, which is unprecedented in the history of OTC derivatives.

AM, Wholesale Market Brokers’ Association: The Financial Conduct Authority has been very explicit that as long as it sees an intent to move down the road of trade reporting and the speed of that movement will be proportionate to the ability of the entity to comply, then it will be happy. The worst that could really happen is that the FCA will threaten to remove authorisation to deal in the markets. I don’t think it needs to jump quickly into a world of fines and a world of persecution. That can come afterwards, but they can certainly threaten to deauthorise if firms are not showing a willingness to start trade reporting.

Although the other issue, and an issue for our members, is that many participants in wholesale markets are not European entities, and therefore are not in the scope of Emir, it may well be that only one side ends up reporting, because the other side is not a European entity. In the wholesale markets, Emir’s trade reporting requirements have been less of an issue because the bigger entities have moved quicker and are in a position to report.

EL, Societe Generale: I, too, think there will be a pragmatic response by the regulators on reporting. There will be a period of time when firms will be able to demonstrate progress to the regulator, as long as that progress is clearly visible. Over time, that pragmatic approach will become much more aggressive and I don’t believe it will be many months before all firms will need to meet their reporting requirements.

DL, Financial News: If parts of the industry do not provide the correct data to the regulators, how long will it take to get to the stage where the data is useful and they can actually spot systemic risk?

AM, Wholesale Market Brokers’ Association: I think we are talking in the longer term but you have to start somewhere in order to get to a position where the systemic risk can be analysed.

Upbeat forecast spells good news for volumes

DL, Financial News: We entered 2014 more optimistically than in previous years. How has that been reflected in trading volumes and activity?

AL, Credit Suisse: From a Credit Suisse perspective, overall we are optimistic. Our outlook for global GDP growth is 3.7% and we think that will surprise markets. US GDP growth is going to be in the region of 3% to 3.25% and even Europe will probably see GDP growth rates of 1% to 1.25%. It is early days, but the signs for equities and bonds are encouraging from a European perspective. In the first three weeks of 2014, European equity volumes were up about 24% on the same time last year.

WK, CME Group: We see a continuation of last year’s trend of volumes picking up. We expect outperformance in terms of interest rates to continue in 2014, especially as quantitative easing starts to tail off. It will be interesting, because there is likely to be a lot of volatility in the market, driven by people’s response to the numbers. There is no consensus yet about how big the growth will be this year.

EL, Societe Generale: Our outlook is mixed. As William said, we will see the continued tailing off of QE, and that will clearly impact fixed-income markets, combined with an economy that is picking up. Although we think the US Federal Reserve will try to keep rates low, there will be some steepening in the rate curve that will put pressure on bond market investments.

We are more positive on equities because we agree the economy is picking up. However, valuations are tight, especially in the US, where it may be difficult to replicate the significant progress we have made in the last year. Europe still has significant inflows, which is helped by a combative policy from the European Central Bank. It is also interesting to look at how primary activity is influencing those inflows. There have been a lot of redemptions in money market funds, as well as inflation-linked and commodities funds, which, to a certain degree, is flowing back into growth-oriented markets.

RM, Investment Management Association: I agree that there is increased confidence in equities. And it’s very significant. One certainly has the impression that many investors had been prepared to sit on the sidelines, so the most significant move may be from cash into equities. Clearly, there will be some risks, particularly on the interest rate side, but the increase in confidence comes after a long period of watching, waiting and wondering where it is safe to invest.

AM, Wholesale Market Brokers’ Association: I think there will be some dispersion in the fixed-income and currency markets, with the US and the Anglo-Saxon economies growing and looking to raise interest rates, whereas in Europe, deflation is still the main focus.

Meanwhile, emerging markets will also see more dispersion, with some of the key emerging market economies of China and India slowing a little. That will probably lead to a mixed outlook for the commodities markets, because demand for commodities comes chiefly from those countries.

DL, Financial News: Tapering is the big looming event of the year, in many ways. We know it is happening, but not necessarily when and how. What impact will it have on trading firms?

EL, Societe Generale: I think we have a good sense of when it is happening. The Fed has been at great pains to telegraph its movements well in advance. We have to remember that it has been buying $85 billion of Treasury bonds and mortgage-backed securities every month, which is an extraordinary injection of cash into the market on a regular basis. It wants to disengage in the least disruptive way.

You also have to look at tightening [raising interest rates]. The Fed has been explicit that it wants to keep interest rates at, or near, zero significantly beyond the time when unemployment falls below 6.5%. This is likely to start being a reality in a year’s time or maybe sooner. I think the Fed will be accommodating in terms of holding rates down.